Monday, February 16, 2015

A Tale of Two Central Banks

"It was the best of times, it was the worst of times, it was the age of Fed debt buying, it was the age of EU mandated austerity, it was the epoch of slow growth, it was the epoch of no growth...

The Unrepentant Capitalist has been reading a lot of articles lately in the business press praising the Americans and criticizing the Euros for their respective responses to the Great Recession of 2009.  When the economy turned south, the US Federal Reserve went interventionist enacting various debt buying programs (TARP, QE1, 2, & 3) while the EU went the austerity route forcing member countries to cut spending and reduce debt.

The consensus of these articles concludes the Fed's actions helped the US to avoid a deeper downturn, while the EU's belt tightening prolonged their problems.  Our economy has been stronger than Europe's when looking at things like GDP and unemployment, but are the pundits jumping the gun when they declare the Fed got it right?

One of the Fed's main jobs is to be the lender of last resort if the markets start to panic.  Economic historians tell us the Fed failed miserably in the early 30's on their lender of last resort duties.  Ben Bernanke knows his history and made sure the Fed didn't sit on their hands this time around.  The cumulative debt buying over the last few years has ballooned the Fed's balance sheet to 4 times its normal size.  Shouldn't we hold off on hanging the 'Mission Accomplished' banner until the Fed gets its balance sheet back to normal size?

And are the Euros' current economic problems all due to belt tightening and central bank passivity?  Even the Libertarian leaning Unrepentant Capitalist is willing to concede that EU austerity measures may have been ill-timed, and a little last resort lending (debt buying) might have been a better course, but the Euros have numerous structural impediments that limit their economic potential.  Relative to the US, the Euros impose more rules and regulations that tend to dampen job creation and steer their economies toward the slow lane.  A couple of exampleslabor laws in Spain compel companies to provide an average of 15+ weeks of redundancy pay to dismissed workers.  Spanish employers must also provide a minimum of 7 weeks paid vacation to workers.  Similar regulations in other EU counties create more cost and risk to prospective employers when it comes to hiring with the net effect of restricting employment.  As of late 2014, unemployment in Spain was running at 24%.   

While central bank policy and government spending are obviously important, the economic growth equation has a lot more variables.  Unfortunately, those other variables often involve policy that politicians are reluctant to change.  In Spain, changing laws to reduce redundancy pay would likely be spun as anti-worker, and therefore difficult to enact.  The Unrepentant Capitalist predicts the Euros will be unable and/or unwilling to address their structural disadvantages, so their debt buying will not do much to get their economy out of the ditch. was the season of Light, it was the season of Darkness, it was the spring of a positive sloping yield curve, it was the winter of 11% Greek government debt, the Fed had a $4 Trillion balance sheet before it, the ECB had 60 Billion Euros of monthly debt buying before it, we were all going direct to Heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only."



  1. You seem to be implying that deregulation would protect against the effects of a financial crisis by enabling job creation. However, several of the countries with the highest rates of new business creation, Hungary, Denmark, Finland, New Zealand, Sweden, Israel and Italy, feature the kinds of policies that you seem to be saying are bad for jobs. The Nordic countries weathered the crisis better than most. Sweden had an even more generous severance package than Spain ( I think that the answer to our and Europes woes will always be more complex than simple deregulation.

  2. Eurozone GDP growth has been anemic for several years running and their unemployment rate is over 11%. They would be doing themselves a favor if they made it easier to hire new workers.

  3. Well then just look at the Nordic countries. They have those policies, so logically, they should have been hit just as hard as Spain or Greece. Why weren't they?

  4. There are lots of variables in the economic vitality equation. The PIGS all have pretty high debt to GDP ratios; all but Spain are over 100, and Spain is close. A lot of the PIGS' debt is externally held.